Why Ford and General Motors Stock Deserve More Respect

The 2019 North American International Auto Show in Detroit this month.
Photograph by Sean Proctor/Bloomberg

Text size

Fourth-quarter automotive earnings can be anticlimactic.

The numbers come after the Consumer Electronics Show in Las Vegas, where auto makers display cool new tech. And they follow the Detroit auto show, when many companies give full-year guidance. Even
Tesla’s
(ticker: TSLA) earnings shouldn’t be a surprise for investors: It already announced fourth-quarter deliveries (and a round of layoffs).

Still, there are big changes afoot in the car business. Investors should tune into the sector this earnings season to learn more.

Ford Motor
(F) kicked off the season on Wednesday. Its fourth-quarter operating earnings missing analyst estimates, although earnings guidance for 2019 appears to be in-line with Wall Street expectations.

Ford reported its first quarterly loss in two years, due to marking its pension assets to market. (Any company that switched its pension accounting from a smoothed “corridor” method to a “mark-to-market” approach will have the same problem. Ford’s U.S. pension plans lost 3.7% in 2018.)

But perhaps the more important takeaway from Wednesday’s report: Over the past two years Ford, has invested nearly $1 billion in its mobility unit, which includes autonomous driving technology, based on our calculations.

The back story: Car stocks have been out of favor for a while. The Russell 3000 Auto & Auto Parts Index fell 23% in 2018, and that is not the worst of it. The index has dropped in three of the last four years in a struggle for auto stocks that coincides with U.S. light-vehicle sales hitting 17 million units annually. Car sales recovered after the financial crisis, but once sales plateaued, investors shunned the stocks.

That occurred even though automotive makers remained profitable. On a combined basis,
General Motors (GM)
and Ford have earned nearly $57 billion in operating income over the past four years. Unfortunately for shareholders, their stocks have declined about 5% a year on average over that span.

Today, a slowdown in sales of vehicles in China is the new headwind facing car companies, and investors don’t seem ready to take a chance on the industry yet. Weak sentiment among investors is reflected in automotive valuations. Car shares trade for about 10 times estimated earnings for 2019. That is a 17% discount to their historical average and 34% below current valuations in the broader market.

The plot twist: Investors should realize that car companies have changed. “GM shares trade only in line with its historical trading range, despite the company being structurally more profitable and less levered than it has been in decades,” JPMorgan analyst Ryan Brinkman notes. GM just can’t get any respect.

Newsletter Sign-up

Ford is in a similar situation. Brinkman writes, “we believe the Ford team is now more focused and working more effectively together than ever before and has accelerated the development of desirable new products that are global in nature.” He adds, “Ford’s aggressively restructured North American operations are now lean and highly profitable.”

Car makers have overhauled themselves to prepare for significant changes under way in the industry. Ride-hailing companies Uber Technologies and Lyft are likely to offer shares to the public in 2019. Electric-vehicle models are proliferating due to government support, as well as falling battery costs. And autonomous driving technology threatens to disrupt traditional models of vehicle ownership. HSBC found in a survey that 18% of frequent Uber and Lyft users say they are less likely to buy or lease a car in the future. That number could go up when the driver is removed from the equation, preserving the anonymity that most travelers desire.

No go: Still, investors should be ready for weak first-half 2019 guidance when the final tallies for 2018 are reported. Industry data provider IHS Markit cut its production forecast in mid-January and China’s economic stimulus isn’t likely to have much effect if trade tensions aren’t resolved. RW Baird analyst David Leiker says car stocks are climbing a wall of worry. He expects flat production and small declines in profit for the automotive companies he covers this year.

Moving forward: Automotive shares have bounced back 7% year to date. For investors who can stomach volatility, there are attractive ways to invest in industry changes. For instance, Leiker recommends buying
Aptiv
(APTV) and
BorgWarner
(BWA), two suppliers he thinks will benefit from autonomous driving and vehicle electrification. JPMorgan’s Brinkman rates shares of both GM and Ford as Overweight. He thinks the old U.S. auto makers don’t get the credit they deserve for restructuring operations before the sales cycle turns against them.

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.